Money Demand and Inflation in Sudan: Instrumental Variable Technique

British Journal of Economics, Management & Trade
SCIENCEDOMAIN international
www.sciencedomain.org
MONEY DEMAND AND INFLATION IN SUDAN: INSTRUMENTAL
VARIABLE TECHNIQUE
Elwaleed Ahmed TALHA
Research Economist Lecturer

Central Bank of Sudan Elrazi University
Research Department. Department of Economics and Finance
Elwaleed.talha@cbos.gov.sd
1. Abstract:
The major objective of this paper is to examine the core determinants of the money demand
function in Sudan during (2003 - 2015). The paper adopts the Instrumental Variable Technique
(IV) in order to investigating the endogeneity of the inflation in response to the money demand.
As a result, the paper finds that inflation affect people behavior of holding money indirectly
through other variables such as the cost of finance, exchange rates, and predominantly the level
of domestic prices. The inflationary gap as well, determines how much money do households need
to hold/spend. The paper suggests that in order to have very well-met quantitative targets, there
is a need for a similar instrument to that one in the conventional system. For instance, some of
the Non-Islamic Central Banks NICBs adopt the policy rate as an instrument; this can be made
for an Islamic Central Bank ICB (e.g. Central Bank of Sudan CBOS). In my point of view, I
argue that tracking and measuring the demand for money would be much more accurate if the
CBOS adopting the (Islamic policy margins)
Key Words: money demand, Inflation, Instrumental Variables, money supply, exchange
rate, CPI
JEL: E41, P24, B23
2. Introduction:
During the period of (1990 2015) the nature of the Sudanese economy has been a
complex phenomenon to investigate. If we trace the economys performance down, it
appears to be fluctuating from slump (1990s) to boom (2000s) to the recession (2011-
2016). For instance, the period of (1990-1998) witnessed high level of inflations when it
got its highest level yet ever of 164% in August 1996. The Sudanese government
apparently realized that there is an urgent need to implement a comprehensive
structural adjustment programs to overcome the crisis. The economic changes over the
given period have affected the dynamic behavior of the inflation through several ways.
http://sciencedomain.org/journal/20/articles-press [1]
In early 1990s, the fiscal dominance was the main cause of hyperinflation attributed to
the huge government deficit resulted from the civil war in South Sudan. This fact stirred
(TALHA, 2016) to argue that hyperinflation of 1990s in Sudan was a fiscal phenomenon
and derived by fiscal factors.
In late 1990s, a dozen of reforming programs implemented in all sectors, primarily to

bounce back the economy to the right track. Some policy makers squabble that such a
recovery would havent happened unless China kicked off its operations to extracting
oil in 1996. The Positive shock of oil was the turning point for the Sudanese economy
and also a radical remedy to the episode of hyperinflation because it (oil revenue)
provides a real source of finance for the government deficit from a genuine resources
rather than relying on money printing and borrowing from the banking system as it
used to be. In truth be told, the exploration of oil was the essential factor behind turning
over the economic situations to an improvement. Nonetheless, there were a couple of
other factors besides it such as central bank independency in 1997 and stimulus
packages introduced by the government thereafter. Moreover, during 2000s, there was a
substantial improvement in the economy and in turn the level of inflation remains
stable at the acceptable levels. For example, during 2000s, inflation rate was 7% (in the
average) which is much lower than when it was in 1990s. For the duration of this period,
the tendency of households and firms to holding money has been shaped in accordance
to the ongoing economic changes, especially the inflation dynamic and the rational
macroeconomic policies.
In order to investigate the responsiveness of the household demand and firms to the
inflation, there is a need to recall the money demand function, which is estimated by an
enormous number of economists such as (EILEEN, JUSOH, & TAHIR, 2010), (Dreger &
Wolters, 2013), (Hall, Swamy, & Tavlas, 2012), (McPhail, 2010) , (Rotheli, 2011),
(Jonsson, 1999), (Oomes & Ohnsorge, 2005), (Nassar, 2005), (Kalra, 1998), and (Oya &
Mangal, 2002). Even so, they go after different econometrics technique (see the
methodology part) and they have to some extend reached to identical results.
The paper adopts the econometrics approach in order to test out that inflation is not
merely derived by the supply side of the money market; but also the demand side is
considered a fundamental factor. Consequently, I will rely on the demand for money
function examined by (MANKIW, 2009), try to slot in it with the quantity theory of
money whenever is possible.
3. The Methodology:
Unlike other scholars who investigate the relationship between inflation and money
demand using different econometrics Techniques other than my technique such as
(Nassar, 2005) and (Kalra, 1998) who employ the error correction model to analyze the
relationship, (Oomes & Ohnsorge, 2005) apply the equilibrium correction model on
their study, (Oya & Mangal, 2002) make use of the Co-integration analysis, and (Rotheli,
2011) utilize the Pascal Technique.
The paper primarily adopts the instrumental Variables (IV) approach which gives
consistent outcomes at the end. As it is addressed by (Stock & Watson, 2013), our IV
model has four types of variables. Y represents the dependent variable, 1 represents
the problematic endogenous regressors like the real interest rate (Islamic Margins) and
the velocity of money, which is correlated with the error term, W additional regressors
called exogenous variables, and Z instrumental variables. In general, there can be
multiple endogenous regressors Xs, multiple included exogenous regressors Ws and
multiple instrumental variables Zs. For IV regressors to be possible there must be at
least as many instrument variables Zs as endogenous regressors Xs as it is indicated in
equation (1)
= 0 + 1 1 + 2 1 + + 1+ 1 + (1)
Where, X is correlated with the error term but W1i Wri are not. In this model,
there is a single endogenous regressor X and some additional included exogenous
variables but it could have a multiple regressors Xs as it is always the case of the money
demand function. Equation (2) shows the population first stage regression of TSLS,
which relates X to the exogenous variables that is the Ws and the instruments Zs.
(Stock & Watson, 2013)
= 0 + 1 1 + 2 1 + + + +1 1 + . . ++ + (2)
= 0 + 1 1 + . + + +1 1 + + + (3)
I=1,., n
Equation (3) illustrates the general IV model, in which is dependent variable,

0, 1, .. +1, are unknown regression coefficients and 1, .. , Are K
endogenous regressores, which are potentially correlated with , 1, .. , are r
included exogenous regressors, which are uncorrelated with or control variables.
is the error term, which represent measurement error and/or omitted factors.
1 . are m instrumental variables . (Stock & Watson, 2013)
4. Theoretical Facts About The Iv Model:

There are three-case for the coefficients of the IV model, the coefficient are over-
identified if there are more instruments than endogenous regressors (m>k), they are
under-identified if (m<k), and they are exactly identified if (m=k). In order to have a
consistent IV regression model, its coefficients have to be either exactly-identified or
over-identified. (Stock & Watson, 2013)
In order to model the money demand function using IV, two main conditions must be
held. Therefore, before using TSLS it is essential to ask whether the two conditions for
instrument validity hold as invalid instruments produce meaningless results it therefore
is essential to assess whether a given set of instrument is valid in our money demand
function (instrument relevance and instrument exogenouty). Where we provide some
statistical tools that help in this assessment. Even with those statistical tools, judgment
plays an important role so it is useful to think about whether the inflation plausibly
satisfies the two conditions. (Stock & Watson, 2013)
1- First consider instrument relevance , because a high inflation rate increases the
real interest rate (margins), therefore the inflation rate plausibly satisfies the
condition for instrument relevance (1 , ) 0
2- Consider instrument exogenouty, for the inflation to be exogenous it must be
uncorrelated with the error term in the demand equation that is inflation must
affect the demand for money only indirectly thorough the margins (price). This
seems plausible. inflation rate varies from state to state and from commodity to
another ( , ) = 0
The TSLS estimator in the general IV regression model with multiple instrumental
variables is computed in two main stages. Our model would be computed in two main
stages. (Stock & Watson, 2013) & (Thomsen, Sandager, Logerman, Johanson, &
Andersen, Introduction to Eviews 7.0, 2013)
1- First stage regressions: regress X1i on the instrumental variables (Z1i,..,Zmi)

and the included exogenous variables (W1i,.,Wki) using OLS
including an intercept . compute the predicted values from this regression; call
this 1 repeat this for all the endogenous regressors X2i,Xki thereby
computing the predicted values 1 . .
2- Second-stage regression: regress Yi on the predicted values of the endogenous
variables ( 1 . . ) and the included exogenous variables
(W1i,.,Wki) using OLS including an intercept . TSLS estimators
0 . . +

are the estimators from the second stage regression.
5. Model Specifications:
The paper principally employs the econometrics approach pointing out to the money
demand function stated on Mankiews textbook (Mankiw, 2012). In addition to that, the
model is underpinned with other scholars work in the field such as (Hall, Swamy, &
Tavlas, 2012) and (McPhail, 2010). Nevertheless, our model integrates some variables
that are not literately considered by Hall (2012) and Phail (2010). The model introduces

the real money balance as a dependent variable while the velocity circulation of
money log (V), inflation rate (), and cost of finance log (cf), which is labeled as a
proxy for the interest rate, exchange rate log (EX) and margins Log (mm) are listed as
independent variables. All variables are tested under the guidance of the theoretical and
empirical evidence.

= ( , +, + , ) (4)

= 0 + 1 + 2 + 3 + 4 + (5)

Where represents the real money balance as a proxy for the money demand,
stands for the velocity circulation of money, is the inflation rate, which is considered
(The instrumental variable inflation is the percentage change in the price measured in Sudanese
pound which is deflated by the CPI), stands for the cost of finance as a proxy for the
interest rate, and points to the nominal exchange rate, and represents finance
margins, which is the portion of the interest that commercial banks charge to the clients.
CPI is integrated into the equation as a proxy for the price levels prevailed in the
economy during (2003-2015)
The major concern of the paper is to find out what derives the demand of households
and firms. In other words, whether the dynamic of inflation has a vital role in
examining the behavior of households and firms in Sudan. In order to end up with very
consistent outcomes, I get to employ the TSLS to further estimate the elasticity of the
demand for money using monthly data for 156 observations from January2003 until
December 2015.
The money demand function is modeled using monthly time series from January 2003
December 2015. Based on equations 6 to 9 that correspond to columns 1 to 4 in table (1)
respectively, I want to investigate what factors inspire people to hold money.

= 0 + 1 () + 2 () + 3 () + 4 () + (6)
() = 0 + 1 () + 2 () + 3 () + (7)

= 0 + 1 () + 2 () + 3 () + (8)
_ = 0 + 1 () + 2 () + 3 () + (9)
Table (1) demonstrates our steps towards running the model using IV approach. In
column(1) and equation (6), our primary model has been estimated by OLS where the

logarithm of the demand for money labeleled as a dependent variable while
the cost of finance Log(cf), exchange rate Log(ex) , inflation () , and the velocity of
money Log(V) as independent variables. Equation (6) and Column (1) in Table (1)
initially shows consistent results, coefficients are merely statistically significant,
adjusted R-squared is 84% which seems plausibly high. However, estimating the money
demand equation by OLS seems to be inconsistent and biased (Thomsen, Sandager,
Logerman, Johanson, & Andersen, Introduction to Eviews 7.0, 2013) . Therefore, I will
estimate it using TSLS
Table (1) TSLS Estimation of the Money Demand Function in Sudan Using
Time Series Data for 156 Observations.
In(MD) In (Inf) In(MD)
Dependent Variable (OLS) (OLS) (TSLS) E_IV
Regressor 1 2 3 4
In(inf) -0.389246 - - -
(0.0000)
-0.182902 0.113760
In(mm) -0.266350 -2.590656
(0.0000) (0.0255)
(0.0000) (0.6822)
-0.977209 -0.615485
In(v) -0.806261 4.778802
(0.0000) (0.0000)
(0.0000) (0.3412)
-0.165598 0.529134
In(ex) -0.459177 7.984332
(0.0006) (0.0000)
(0.0000) (0.1530)
S. E. of the regression 0.11 0.14 0.13 18.06

Adjusted R-squared 87% 93% 83% -2%
Instrumental Variable(s) Ex
U mm
U Ex, mm ,& v
U
First Stage F-statistics 265.4239 749.1179 276.6027

0.0000 0.0000 0.0000 -
18.89268
J-test and P-value - - -
0.000014
More importantly, inflation rate is suspected to be an endogenous variable, thus, there

is a need to test its relevancy to the potential instrument(s). To get this step done, an
auxiliary regression ought to be estimated by regressing the log of inflation rate ()
on the log all the explanatory variables and the log of the potential instrument as well
which assumes to be positively/negatively correlated with the rate of inflation
(1 , ) 0 but uncorrelated with the error term ( , ) = 0making it good
candidates for instrument. . Consequently, the coefficient on the log (ex) in column (2) is
statistically significant to making it a relevant instrument. In column (3), another
regression is estimated using TSLS method, the regression incorporates the log of the
exogenous explanatory variables as instruments for themselves and log of exchange
rate as instrument for the log of inflation. As it can be seen, the standard error in
column (3) is slightly lower than the standard error in column (1). This makes the
potential instruments stronger than when the OLSs standard error be greater than the
TSLSs one and thus the model is free from the problem of the endogeneity .
Turning to the exogeneity condition, in order for the inflation to be exogenous, again, it
has to be uncorrelated with the error term in the demand equation ( , ) = 0. In
other words, inflation has to influence the demand for money in an indirect way, say,
through either exchange rate or the cost of finance. This seems to be probable as
inflation differs from state to state and from commodity basket to another.
Table (2) Endogeneity Test for the

Inflation rate
Value df Probability
Difference in J-stats 8.644083 1 0.0033
J-statistic summary:
Value
Restricted J-statistic 8.644083
Unrestricted J-statistic 0.000000
0 : indicates that inflation can be considered as an exogenous variable, while1 : points that
inflation cannot be considered as an exogenous variable.
In Table (2), the null hypothesis H0 shows that there is no differences between the
model where inflation as an endogenous variable and the model where inflation rate as
an exogenous variable. Therefore, we cannot reject the null hypotheses, which say that
inflation can be considered exogenous variable. However, LM-test is another method
for judging about the instruments validity. In order to calculate LM-statistics, an
auxiliary regression has to be estimated along with the error terms using TSLS by
regressing the error term as a dependent variable (residuals) on all the explanatory
variables and instruments excluding endogenous variable in a logarithmic form .(see
column-4) (Thomsen, Sandager, Logerman, Johanson, & Andersen, Introduction to
Eviews 7.0, 2013).
Figure [1] CPI, EX, MM, And MD Residuals

LOG(CPI) Res iduals LOG(EX) Res iduals
.15 .8
.10
.6
.05
.4
.00
.2
-.05
.0
-.10
-.15 -.2
03 04 05 06 07 08 09 10 11 12 13 14 15 03 04 05 06 07 08 09 10 11 12 13 14 15
LOG(MM) Res iduals LOG(MD) Res iduals

0.4 .15
0.0
.10
-0.4
-0.8 .05
-1.2 .00
-1.6
-.05
-2.0
-2.4 -.10
03 04 05 06 07 08 09 10 11 12 13 14 15 03 04 05 06 07 08 09 10 11 12 13 14 15
The results of our model are presented in Table (1), which has four columns; each
column contains every step of the IV approach illustrated in the table. For example,
equations (6 to 9) correspond to column (1 to 4) respectively, this leads us to point out
that all regressors have the same regression and all coefficients are estimated using
TSLS except column (1) & (2) that correspond to equation (6) & (7) respectively. The
little differences between the four regressions are the group of instruments
incorporated. In column (1) for instance, the log of exchange rate Log (EX), margins, and
the log of velocity of money Log (V) are labeled to be the only instrument used in this
model.
Fortunately, based on the diagnostic analysis, it is found that the instruments Log (EX)
and Log (V) are strongly relevant to the endogenous variable. Therefore, it is crucial to
look at the first stage F-statistics, which is the square of the t-statistics examining that all
the coefficients on the IV Log (ex) and Log (mm) equals zero. In terms of column (2) and
(3) the first stage F-squares are 749.11 and 276.60 respectively. So in all three models, the
first stage F-statistics exceeding 10 which is an indication that exchange rate and
margins are strong instruments.
However, the regression in column (3) there are two instruments Log (EX) and Log(mm)
and a single included endogenous variable. It is yet over-identified because there are
two instruments and a single included endogenous regressor. So there is one (m-k=z-
1=1) over identifying restriction. In this case we are required to investigate J-statistics,
which is according to Stock & Watson,the basic idea of the J-statistic is that If both
instruments are exogenous the TSLS estimators using the individual instrument are
consistent and differ from each others only because the random sampling variation. If
however, one of the instruments is exogenous and one is not then the estimator based
on the endogenous instrument in inconsistent, which is detected by the J-statistics
(Stock & Watson, 2013).
in table (2), J-statistics is 8.6, this tells that in case of 5% critical value, we are going to
reject the null hypotheses that both instruments are exogenous and accept the
alternative one that both instruments are not exogenous (the exogeneity condition fails).
This yields three alternatives. The first case, the exchange rate is exogenous by margins
is not, in such a case column (1) regression is reliable. The second case, the margins is
exogenous but exchange rate is not, in which case, the regression in column (2) is
reliable. The third case is that neither one is exogenous, so neither column (1) and (2)
nor column (3) is reliable.
One might argue that the case of exogniety of the exchange rate is stranger than for the
cost of finance as the macroeconomic theory relates changes in the cost of finance (See
to changes in the demand side of the money market and inflation dynamic Figure [2]
and Figure [3]. For instance, if inflation rate goes down the cost of borrowing would be
less expensive and people would have no incentives to hold money. Specially, when
commercial banks take this advantage to maximize their profitability. In contrast,
during the recession, rates of inflation tend to be higher, households and firms in such
cases, are eager not to increase their spending patterns in anticipation that the situation
would be improving. It might be the case of when a central bank adopts the inflation
targeting approach. In Sudan however, CBOS targets the growth in money supply as an
operational target to steering inflation rate. Based upon it, there is no any sort of
information that can assist household and firms to form proper anticipations for the
long-term in favor of their ultimate objectives utility and profit respectively.
6. Policy Implication:
In this part, I will examine whether the money demand is elastic and what the main
factors influence the demand side of the money market in Sudan. My initial model in
Column (1) in Table (1) indicates that demand for money tends to be elastic to the
inflation rate, exchange rate, and margins.
As inflation measures how fast prices increase, the effect on households and firms is
minimal and indirect through the level of prices. Economic Theory tells us that high
levels of inflation motivate people not to spend their money meanwhile in anticipation
of lower future inflation. Such a behavior would definitely be modified in case of lower
expecting inflation. It is more likely to be one of the reasons behind labeling inflation as
an included indigenous variable.
Figure-[2] Inflation Rate and Money Demand in Sudan during (Jan. 2003 Dec. 2015)
INF MD
50 240
40
200
30
160
20
120
10
80
0
-10 40
03 04 05 06 07 08 09 10 11 12 13 14 15 03 04 05 06 07 08 09 10 11 12 13 14 15
Column (1) in Table (1) shows a negative relationship between inflation and the
demand for money. An increase in inflation rates by 1% tends to lower the demand for
money by 3.8% given other variables consistent. This result has two crucial implications
on our paper. The first one is that households relying on inflation to make their decision
of money holding/spending. In fact people are indirectly influenced by inflation
through the fluctuation in the price. So as far as households concerned, the level of
prices prevailed in the market modifies their spending pattern and not the level of
inflations. Conversely, the second implication is related to whether firms are affected
directly or indirectly by the level of inflation. In this regards, I would argue that firms
are much more concerned about the level of inflation than what households do. In the
sense that firms do adjust their pricing decision in accordance to the inflation rate
announced by the Central Bank of Sudan CBOS on its annual policy outlook. This
implies that firms are also influenced indirectly through level of prices. But we have to
distinguish between firms and households behaviors towards holding/spending
money. Firms for example, hold money in order to purchase required inputs for the
production process. Yet, households hold money in order to purchase goods and
services and moreover to maximize their utility. There is one reason jointly used by
both firms and households, which is holding money for speculation specially in the
Forex market.
Figure [3] shows how responsive inflation to the money demand according to the
impulse response test, inflation rate is very sensitive to the money demand but the
demand for money is not very responsive to inflation rate.
Figure-[3] the Impulse Response of (Inflation, exchange rate, and Margins to the
Money Demand)
Response to Cholesky One S.D. Innov ations 2 S.E.

Response of LOG(CPI) to LOG(CPI) Response of LOG(CPI) to LOG(EX) Response of LOG(CPI) to LOG(MM) Response of LOG(CPI) to LOG(MD)
.04 .04 .04 .04
.03 .03 .03 .03
.02 .02 .02 .02
.01 .01 .01 .01
.00 .00 .00 .00
-.01 -.01 -.01 -.01

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of LOG(EX) to LOG(CPI) Response of LOG(EX) to LOG(EX) Response of LOG(EX) to LOG(MM) Response of LOG(EX) to LOG(MD)
.08 .08 .08 .08
.06 .06 .06 .06
.04 .04 .04 .04
.02 .02 .02 .02
.00 .00 .00 .00
-.02 -.02 -.02 -.02

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of LOG(MM) to LOG(CPI) Response of LOG(MM) to LOG(EX) Response of LOG(MM) to LOG(MM) Response of LOG(MM) to LOG(MD)
.3 .3 .3 .3
.2 .2 .2 .2
.1 .1 .1 .1
.0 .0 .0 .0
-.1 -.1 -.1 -.1

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of LOG(MD) to LOG(CPI) Response of LOG(MD) to LOG(EX) Response of LOG(MD) to LOG(MM) Response of LOG(MD) to LOG(MD)
.04 .04 .04 .04
.02 .02 .02 .02
.00 .00 .00 .00
-.02 -.02 -.02 -.02
-.04 -.04 -.04 -.04

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
The estimated coefficients of OLS model in column (1) demonstrate that there is a
negative relationship between the cost of finance and the demand for money. In other
words, given other variables consistent, the increase in the cost of finance by 1%, leads
the demand for money to decrease by 1.8%. Having this result, it is hard to prop up this
argument by the economic theory as it does not have any explanation regarding the
Islamic margins. Nevertheless, I would endeavor to justify the cost of finance by the
same interpretation given to the nominal interest rate theory in spite of the huge
differences between the two.
According to the money demand assumptions, households tend to hold money when
there is an increase in the cost of finance and decide to move on an alternative source of
investments that can give them a satisfied level of return over time. As commercial
banks increase the Islamic margins in accordance to the CBOSs policies, households
and firms would be less eager to demand money in order to carry out any profit-
directed transactions.
It is worth mentioning that the result is statistically consistent with the econometrics
and economic theory. T- Statistics is well below 0.05. This leads us not to reject the null
hypothesis, which says that there is strong negative link between cost of finance and the
behavior of households and firms towards holding money.
Figure-[4] the Growth Rate in the Money Demand and Islamic Margins
.3
.2
.1
.0
-.1
-.2
-.3
03 04 05 06 07 08 09 10 11 12 13 14 15
MMG MDG
Empirical evidence in Sudan indicates that CBOS made a huge reduction in Murabha
Margins from 16.4 in 2003 to 11.2 in 2004. The growth of the margins was the highest in
2004 by 32%; this was mainly attributable to the central bank tendency to encourage
households and firms to inject their cash into the banking system in order to stimulate
investment. In same year, the demand for money increase as margins decrease.
In table (1), column (3), the coefficients are highly sensitive to the money demand using
TSLS. The result here seems to be more consistent than in column (1). The result
indicates that as the CBOS increase the Islamic margins by 1%, the demand for money
will decrease by 2.7%.
Our model in column (1) indicates that there is a negative consistent relationship
between the exchange rate and people motivation of holding money. As the exchange
rate depreciate by 1%, the demand for money will increase 1.6%, which means that
households will have more incentives to hold money. The TSLS model in column (3) is
much more reliable. It points out that the sensitivity of the exchange rate to in demand
for money is 4.5% negatively correlated.
In this regards, (MANKIW, 2009) addresses that the interest rate determines the amount
of money people want to hold as the opportunity cost. (TALHA, 2016) however
assumes that both interest rate and exchange rate are the opportunity costs for each
others , which means people are oriented towards where the higher return exists but
they also take into account risks associated to exchange rate fluctuations and interest
rate movements. In Sudan, for example, exchange rate is considered as a safe asset and
the risk associated was relatively lower during hyperinflation period than the interest
rate risks because of the oil productions and Bank of Sudan policies towards the Foreign
exchange Market in 1996.
Figure-[5] the Growth Rate in the Money Demand and Islamic Margins.
.7
.6
.5
.4
.3
.2
.1
.0
-.1
03 04 05 06 07 08 09 10 11 12 13 14 15
IN(EX) MDG
7. Conclusion and Policy Recommendations:

To wrap-up, the paper concludes that the demand for money is not derived by the
inflation rates in a direct way. Empirically, households and firms are not affected
directly by the inflation rate rather than the level of the prices. Nevertheless, our model
in table (1) Column (1) indicates that inflation rate is statistically significant to the
demand for money. But this argument does not imply the existence of the direct impact
of inflation on the money demand. The question remains, do households and firms feel
the inflation rates? Definitely they dont, they rather feel the over-all change in the
domestic prices. This means that their reaction would be as a response to the prices not
inflation rates.
More importantly, the over-all impact on the money demand comes indirectly from the
inflation through the exchange rate, Islamic margins, or prices levels. For Instance,
during the recession, rates of inflation tend to be high; people in this case would be
encouraged to hold their money in safe assets rather than spending it or demanding
extra cash. In contrast, during the boom, rates of inflation are lower than in the
recession, people have more incentives to demand money because of the cheap cost of
borrowing.
In Sudan, exchange rate is considered as a safe asset for speculators specially during the
post-secession period and exactly right after the first and the second devaluation.
During 2000s people used to hold money for speculating in the real-state and auto-
motors sector. The CBOS realized no positive impact for these sectors on the economy
due to this the CBOS decided to prohibiting and restricting commercial banks from
providing finance to such sectors. Alternatively, Speculators move to the Forex market,
where there is a profitable environment due to the huge depreciation in the Sudanese
pound. This argument underpin TALHAs argument, which says that not only interest
rate, but also exchange rate fluctuations determines people demand for money and thus
money supply (TALHA, 2016)
In order to have very well-met quantitative targets, there is a need for a similar
instrument to that one in the conventional system. Non-Islamic Central Banks adopts
the policy rate as an instrument; this can be done in the case of the Islamic Central
Banks ICB. In my opinion, I argue that tracking and measuring the demand for money
would be much more accurate if the CBOS adopting the (policy margins).
8. References
Dreger, C., & Wolters, J. (2013, April). Money demand and the role of monetary indicators in
forecasting euro area inflation. ((www.wifo.ac.at), Ed.) FIW Working Paper N 119 .
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Dependent Variable: LOG(MD)

Method: Least Squares
Date: 06/01/16 Time: 12:21
Sample: 2003M01 2015M12
Included observations: 156
Variable Coefficient Std. Error t-Statistic Prob.
C 7.629198 0.275033 27.73917 0.0000

LOG(MM) -0.182902 0.039425 -4.639243 0.0000
LOG(EX) -0.165598 0.047486 -3.487338 0.0006
LOG(V) -0.977209 0.049180 -19.86988 0.0000
LOG(CPI) -0.389246 0.062374 -6.240522 0.0000
R-squared 0.875484 Mean dependent var 5.053484

Adjusted R-squared 0.872186 S.D. dependent var 0.310282
S.E. of regression 0.110930 Akaike info criterion -1.528317
Sum squared resid 1.858109 Schwarz criterion -1.430566
Log likelihood 124.2088 Hannan-Quinn criter. -1.488615
F-statistic 265.4239 Durbin-Watson stat 0.489033
Prob(F-statistic) 0.000000
Dependent Variable: LOG(CPI)

Date: 06/01/16 Time: 12:22
Sample: 2003M01 2015M12
C 4.150467 0.120761 34.36915 0.0000

LOG(MM) 0.113760 0.050431 2.255758 0.0255
LOG(EX) 0.529134 0.044397 11.91834 0.0000
LOG(V) -0.615485 0.039973 -15.39743 0.0000

S.E. of regression 0.144252 Akaike info criterion -1.009203
Sum squared resid 3.162914 Schwarz criterion -0.931002
Log likelihood 82.71784 Hannan-Quinn criter. -0.977441

Method: Two-Stage Least Squares
Date: 06/01/16 Time: 12:18
Sample: 2003M01 2015M12
Instrument specification: EX MM V M2
Constant added to instrument list
C 6.212470 0.118146 52.58305 0.0000

LOG(MM) -0.266350 0.050207 -5.305019 0.0000
LOG(V) -0.806261 0.037002 -21.78943 0.0000
LOG(EX) -0.459177 0.041136 -11.16240 0.0000

S.E. of regression 0.127174 Sum squared resid 2.458346
Prob(F-statistic) 0.000000 Second-Stage SSR 1.501890
J-statistic 18.89268 Instrument rank 5
Prob(J-statistic) 0.000014
Dependent Variable: E_IV

Date: 05/26/16 Time: 11:40
Sample: 2003M01 2015M12
C -3.246977 15.12142 -0.214727 0.8303

LOG(V) 4.778802 5.005337 0.954741 0.3412
LOG(MM) -2.590656 6.314812 -0.410251 0.6822
LOG(EX) 7.984332 5.559225 1.436231 0.1530
R-squared 0.014684 Mean dependent var -4.25E-14

Adjusted R-squared -0.004763 S.D. dependent var 18.01999
S.E. of regression 18.06285 Akaike info criterion 8.650898
Sum squared resid 49592.50 Schwarz criterion 8.729100
Log likelihood -670.7701 Hannan-Quinn criter. 8.682660
Endogeneity Test
Equation: EQ03
Specification: LOG(MD) C LOG(MM) LOG(V) LOG(EX)
Instrument specification: C EX MM V M2
Endogenous variables to treat as exogenous: LOG(MM) LOG(V) LOG(EX)
Value df Probability
Difference in J-stats 88.27139 3 0.0000
J-statistic summary:
Value
Restricted J-statistic 108.1422
Unrestricted J-statistic 19.87086
Restricted Test Equation:

Date: 06/07/16 Time: 15:14
Sample: 2003M01 2015M12
Instrument specification: C EX MM V M2 LOG(MM) LOG(V) LOG(EX)
C 6.013645 0.103811 57.92864 0.0000

LOG(MM) -0.227183 0.043352 -5.240380 0.0000
LOG(V) -0.737634 0.034363 -21.46623 0.0000
LOG(EX) -0.371562 0.038165 -9.735642 0.0000

Prob(F-statistic) 0.000000 Second-Stage SSR 2.337330
J-statistic 108.1422 Instrument rank 8
Prob(J-statistic) 0.000000
Unrestricted Test Equation:

Date: 06/07/16 Time: 15:14
Sample: 2003M01 2015M12
Instrument specification: C EX MM V M2
C 6.212470 0.115201 53.92713 0.0000

LOG(MM) -0.266350 0.048956 -5.440620 0.0000
LOG(V) -0.806261 0.036080 -22.34640 0.0000
LOG(EX) -0.459177 0.040111 -11.44772 0.0000

Durbin-Watson stat 0.530504 J-statistic 19.87086
Instrument rank 5 Prob(J-statistic) 0.000008

Money Demand and Inflation in Sudan: Instrumental Variable Technique

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British Journal of Economics, Management & Trade

Research Economist Lecturer

JEL: E41, P24, B23

In late 1990s, a dozen of reforming programs implemented in all sectors, primarily to

Equation (3) illustrates the general IV model, in which is dependent variable,

4. Theoretical Facts About The Iv Model:

1- First stage regressions: regress X1i on the instrumental variables (Z1i,..,Zmi)

S. E. of the regression 0.11 0.14 0.13 18.06

First Stage F-statistics 265.4239 749.1179 276.6027

More importantly, inflation rate is suspected to be an endogenous variable, thus, there

Table (2) Endogeneity Test for the

Figure [1] CPI, EX, MM, And MD Residuals

LOG(MM) Res iduals LOG(MD) Res iduals

Response to Cholesky One S.D. Innov ations 2 S.E.

.03 .03 .03 .03

.02 .02 .02 .02

.01 .01 .01 .01

.00 .00 .00 .00

-.01 -.01 -.01 -.01

.06 .06 .06 .06

.04 .04 .04 .04

.02 .02 .02 .02

.00 .00 .00 .00

-.02 -.02 -.02 -.02

-.1 -.1 -.1 -.1

.02 .02 .02 .02

.00 .00 .00 .00

-.02 -.02 -.02 -.02

-.04 -.04 -.04 -.04

7. Conclusion and Policy Recommendations:

Mankiw, N. G. (2012). Macroeconomics. USA: Harvard University Press.

MANKIW, N. (2009). MACROECONOMICS. Boston: Harvard University: worth publisher.

Dependent Variable: LOG(MD)

Variable Coefficient Std. Error t-Statistic Prob.

C 7.629198 0.275033 27.73917 0.0000

R-squared 0.875484 Mean dependent var 5.053484

Dependent Variable: LOG(CPI)

Variable Coefficient Std. Error t-Statistic Prob.

C 4.150467 0.120761 34.36915 0.0000

R-squared 0.936650 Mean dependent var 5.125409

Dependent Variable: LOG(MD)

Variable Coefficient Std. Error t-Statistic Prob.

C 6.212470 0.118146 52.58305 0.0000

R-squared 0.835261 Mean dependent var 5.053484

Dependent Variable: E_IV

Variable Coefficient Std. Error t-Statistic Prob.

C -3.246977 15.12142 -0.214727 0.8303

R-squared 0.014684 Mean dependent var -4.25E-14

Restricted Test Equation:

Variable Coefficient Std. Error t-Statistic Prob.

C 6.013645 0.103811 57.92864 0.0000

R-squared 0.843370 Mean dependent var 5.053484

Unrestricted Test Equation:

Variable Coefficient Std. Error t-Statistic Prob.

C 6.212470 0.115201 53.92713 0.0000

R-squared 0.835261 Mean dependent var 5.053484

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